How to Avoid Currency Losses in Emerging Markets

In 2013, many executive missed performance targets despite meeting volume and market share goals. The culprit was exchange-rate volatility, which caused many companies to miss revenue and profit targets after local currencies were translated to dollar or euros. According to FiReAPPS, US-based multinationals lost an estimated $17.8 Billion dollars in 2013 due to exchange-rate fluctuations in emerging markets.  For an emerging market executive, a 10% gain in profit and sales in a given market was wiped out by a 10% decrease in the value of the local currency.  The list of emerging market currencies that depreciated by more than 10% against the US dollar is extensive, including: The Russian ruble, Indonesian rupiah, Brazilian real, South African rand, and Turkish lira.  Currency depreciation turned local-market success stories into earnings disappointments.

FX Quarterly Q1 2014 Blog Post Image 1

*Source: Frontier Strategy Group analysis, Bloomberg

With the risk-return payoff for shifting towards developed markets, executives should consider high levels of emerging market currency volatility to be a given in 2014.  Exchange-rate volatility can wreak havoc on internal operations and business partners, but its effects can be mitigated. A cross-functional approach to contingency planning ensures that all key elements of a business including, sales, supply chain, talent and finance are ready for the next bout of turbulence.  The question for emerging market leaders should be how to manage volatility, not how to avoid it.  This problem should be solved at the local and regional level, no longer just at the corporate treasury. Emerging market executives have a number of operational strategies in their arsenal for minimizing the impact of FX fluctuations.

Before choosing or recommending a course of action, it is vital to determine an organization’s objective in managing currency volatility. Many companies focus simply on maintaining margin in an environment characterized by currency volatility. More opportunistic companies will use the environment to build market share.   The strategies detailed in our FX Quarterly series can be implemented with little to no support from the corporate treasury.

FX Quarterly Q1 2014 Blog Post Image 2

*Source: Frontier Strategy Group analysis

Emerging-Market Meltdown? It’s Time for Action, Not Distraction

The financial media has been dominated by cries of “Emerging-Markets Crisis” in the past week, as both currencies and stock markets tumbled. Corporate executives would be well served to turn off the television and instead take a second look at their 2014 business plans.  Multinational companies have their work cut out for them to ensure a successful year ahead, so it is essential that their emerging-market executives separate signal from noise and focus on their most important management challenges.

With the media focused on hour-by-hour events, I hope to provide FSG clients with a big-picture view that puts recent news in perspective and integrates the comprehensive resources you have available today. First, let’s clarify what’s really been happening in the markets, and what is truly relevant to corporate leaders.

1.    Corporate investment in emerging markets remains strong, despite capital-market volatility.

Companies with global ambitions are doubling down on developing markets, not retreating. More than 60% of corporate foreign direct investment went to emerging markets in 2013, despite portfolio “hot money” moving in the opposite direction. FSG’s MNC sentiment tracking shows that interest in frontier markets has doubled in the past year, indicating likely direct-investment increases in even riskier (and still fast-growing) markets.

The crisis today is one of confidence among money managers, as “tapering” of the US Federal Reserve’s quantitative easing program increases their cost of capital. A lower risk appetite has naturally reversed the flow of capital into emerging markets that surged in 2009. The economic fundamentals of most emerging markets have not changed notably, other than the effects of the currency volatility itself.

We have seen this movie before, in May 2013’s “taper tantrum” and its August sequel, when uncertainty over the timing of Fed tapering triggered abrupt emerging-market currency selloffs. The Brazilian real, for instance, lost and then regained over 12% of its value over the span of six weeks in August and September – and lost it again starting in November. Everyone knows the Fed will reduce stimulus further over time, which means further pullbacks from higher-risk markets are inevitable. So, the surprise last week was just about timing, not substance.

2.    The media uses “emerging-markets crisis” as shorthand, but last week’s market turmoil was really about relatively few countries – and the news was not as startling as portrayed.

Yes, there are real reasons for MNCs to be concerned about political instability in Turkey and Ukraine, and economic policies in Argentina and China – all of which have dominated headlines recently. But at least for FSG clients, these risks should have already been built into 2014 plans.

Our September report on 2014 Global Performance Drivers highlighted Ukraine, Turkey, and Argentina as most vulnerable to a liquidity crisis because of their high levels of short-term external debt. For such countries, even moderate changes in investor sentiment cause major currency movements. Unfortunately, the media tends to gloss over key differences in their market fundamentals that matter to companies.

3.    Don’t let fear of “contagion” cloud your analysis of emerging-market opportunities.

“Contagion” implies that markets with real problems are tightly connected, so that a liquidity crisis or spending crunch in one will swiftly spread to many others. The markets that were most troubled last week generally do not have tightly linked financial markets. Trade links generally connect emerging economies more tightly with developed markets than with each other (with China a notable exception). We believe that corporate planners should be more concerned about downward pressure on emerging-markets growth resulting from linkages with the stagnant Eurozone than from linkages with a volatile Argentina or Ukraine.

4.    Managing currency volatility should be a top priority for MNC leaders in 2014.

The most serious risk is not of contagion collapsing currencies across emerging markets, but rather repeat bouts of currency volatility driven by fund-manager portfolio reallocation and herd mentality. This can have deeply disruptive effects. Our Events to Watch in 2014 report lists currency volatility as the most likely cause of 2014 plans going awry. As a result, we have initiated regular coverage of currency movements and trends for FSG clients in our new FX Quarterly series, which we will update at the end of February.

Some markets are likely to experience extreme volatility on an ongoing basis (Argentina, Iran, Syria, and Belarus top our volatility index forecast). FSG analysts are closely watching indicators such as short-term external debt, current-account balances, and portfolio capital outflows to monitor when markets are in the greatest danger of a currency crunch, and we encourage you to do the same using FSG’s Monthly Tracking Tool.

5.    Take action now to mitigate the impact of currency volatility on your 2014 performance.

Currency volatility can wreak havoc on internal operations and among business partners, but its effects can be mitigated. A multi-functional approach to contingency planning ensures that all key domains – from sales to supply chain, from talent to finance – are ready for the next bout of turbulence.  The question for emerging-market leaders is how to manage volatility, not how to avoid it.

  • Formulate contingency plans for profit repatriation

Currency depreciation can turn what seems like a local-market success story into an earnings disappointment from the corporate perspective. The worst-hit markets may compound the problem by instituting capital controls to prevent further flight and devaluation. Given the recent “pivot to profitability” in how emerging-market executives’ targets are set (as opposed to traditional revenue targets), regional general managers’ careers may suffer in the absence of a structured profit repatriation strategy.

  • Support local partners

Most MNCs depend on local distributors, suppliers, and other partners who lack the scale or sophistication to manage an extended period of currency volatility. Proactively providing liquidity, attractive repayment terms, and temporary discounts could earn enduring loyalty – and even turn an arms-length relationship into an affordable acquisition opportunity.

  • Evaluate product localization

Consider adopting a localization strategy to mitigate the impact of these possible scenarios by producing and sourcing locally. Factoring in currency impacts to market-share gains and government incentives may change previous cost-benefit assessments of going local.

  • Review your geographic portfolio

Identify the fundamentally healthy markets where companies are likely to pull back but your company is underpenetrated – many markets with strong domestic demand as their key economic driver should be less affected once the dust settles. Smart companies are adjusting their geographic footprint by assessing regional opportunity at the level of provinces (e.g., ASEAN and Latin America) and country opportunity at the level of cities (e.g., Russia and India).

  • Consider investing more aggressively in frontier markets

While many emerging-market forecasts have been revised downward, frontier markets have exhibited much stronger performance, in terms of both growth expectations and equity-index performance.  Markets such as Nigeria, Peru, and Kazakhstan will be resilient regardless of currency shocks, thanks to their modest short-term debt and healthy levels of private consumption.

6.   Executives in emerging markets must aggressively manage perception and expectations at the corporate center.

The very experience that makes seasoned emerging-market leaders unfazed in a period of volatility can make them forget how their colleagues at headquarters feel when the names of far-off markets are suddenly crawling across their TV screens day after day. When investors get nervous, the Board, CEO and CFO have to justify their investments in emerging markets that they may not even think about on a regular basis. When that happens, it’s essential that expectations and assumptions are well aligned between the corporate center and leaders in the regions.

  • Reassess 2014 targets and resource allocation

Companies should adjust forecasts down in the markets experiencing the most acute currency devaluation. Central banks may raise interest rates to support the currency and maintain prices on imported goods. The trade-off for higher rates will be slower-than-expected economic growth. As economic conditions change on the ground, any changes to corporate targets and plans should be swift and data-driven.

  • Get corporate buy-in to triggers for mid-year course correction

It’s time to be proactive in resetting expectations and, if necessary, re-making the business case for emerging-market investment. Regional GMs and country managers should demonstrate that they have specified key risks to the plan (FSG’s short list of Events to Watch in 2014 spans all regions of the globe), and have documented contingency plans. Agree in advance on events that would trigger a reset of goals or course correction in strategy. Companies that systematically monitor and adjust to changes in emerging markets grow market share twice as fast.

Don’t let Wall Street distract you from execution – or rewrite your business plans.

As an executive responsible for international growth, in a time like this it’s essential to not be distracted by the media’s emerging markets storyline. Keep your eye on what matters to your company’s success, and the timeframe in which you are committed to deliver results. You don’t control the markets, but you can control your business.

Do You Know Which Emerging Market Is At Risk Of A Liquidity Crisis?

Ukraine Liquidity Crisis
The economy of Ukraine is in serious trouble. To provide some context, Standard & Poor’s recently downgraded the quality of Ukraine’s debt to the same level as Greece.  With a current account deficit of about 8 percent of GDP, Ukraine’s rapidly diminishing foreign currency reserves stand around only 2.5 months of import cover.  In the next couple of months, Ukraine’s debt repayments could exceed their cash reserves, leading to a balance-of-payments crisis and possible default.  With recent economic data all pointing toward an increasingly deteriorating macro-environment, executives operating in Ukraine need to be prepared for the worst.  Even though the country has been able to teeter on the brink of default for an extended period of time so far, the risk and consequences for multinationals are so significant, that companies need to have a plan in place in case this risk materializes.

There is plenty of literature on the reasons for Ukraine’s issues, but not much information on the potential business impacts.  So what would a liquidity crisis mean?  For multinationals, there would be three main effects:

  1. First, expect a large devaluation (perhaps as large as 30%) of the Hryvnia.
  2. Second, both B2B and B2C multinationals’ ability to get paid will suffer as systemic credit dries up.
  3. Third, governmental policies would shift toward populist measures in order to appease the electorate in advance of 2015 presidential elections.  These measures could include increased import tariffs and subsidies for domestic producers, giving advantage to companies that are able to produce locally.

To better gauge the specific implications of Ukraine’s liquidity crisis, FSG has identified the industry-specific consequences below.



Consumer Goods/Retail Supported by wage increases, consumer demand has been the strongest driver of the economy.  FSG expects consumer spending to slow dramatically as consumer demand is rapidly depressed by the Hryvnia’s devaluation and combined with slowing wage growth.  This would also impact the government’s ability to pay salaries, pensions, and other social benefits, further harming consumer expenditure.  In previous instances of liquidity crises, consumers have shifted their spending patterns to more traditional channels such as mom and pop stores in response.
Healthcare Accounts receivables will come under pressure as both public and private entities struggle to meet payment obligations.  With the public sector supplying 55% of the total health expenditure in 2013, multinationals should anticipate both decreases and delays in reimbursement.
Heavy Industry Expect delays and/or cancellations of infrastructure developments and capital-intensive projects as government funds are shifted toward urgent repayment capacity.  B2B demand will also weaken as local companies face credit availability issues and lower purchasing power from a devalued Hryvnia.
Technology In an effort to protect domestic industry, companies importing hardware goods into Ukraine can expect challenges around inconsistent policies and changing regulations.  Companies that are reliant on improving infrastructure in their strategic expansion plans will also need to consider alternative strategies for growth as major projects face long delays.

For more information on Ukraine’s looming crisis, FSG clients can refer to FSG’s latest podcast on the situation in the country.

FSG’s CEO Richard Leggett on MNCs in Emerging Markets—Harvard Business Review

This past Thanksgiving, FSG’s CEO, Richard Leggett posted an article on Harvard Business Review’s website. Weaving in anecdotes from his extensive client experiences and FSG data studies, the article discusses how multinational companies (MNCs) are dealing with the recent economic slowdown in the BRIC countries. While companies face lower growth in traditional emerging market strongholds, they still expect emerging markets to contribute to both high profits and high growth in sum.

The increased focus on emerging markets as a source of corporate profits is a dramatic shift from when FSG first opened its doors in the early 2000s. Corporate expectations at headquarters were low and regional executives were primarily charged with expanding market share. Today, MNCs have adopted a dual strategy of “going deep” in markets while simultaneously and aggressively pursuing the next frontier markets.

The article goes on to raise examples from across the globe. In Asia, as growth is slowing in China and India, MNCs are increasingly looking to ASEAN countries. Indonesia has attracted MNC attention as it has a young and urban growing middle class that will sustain growth. In Indonesia however, there are other considerations for MNCs to address such as high transportation costs compared to the region and corruption. In Africa, the Nigerian economy is perhaps the most exciting frontier market in the world. Due to a complete overhaul in how GDP is calculated, Nigeria will become the largest market in Africa in 2014. An example of the impressive growth Nigeria’s strong fundamentals are supporting is the automobile market which has seen in some cases a 33% increase in sales.

Please follow this link for the original article that discusses each case in detail.

China’s Shadow Banks Impact Your Global Business

China is the world’s second-largest economy yet many executives ignore it as a source of systemic risk to their global business. The biggest risk in China surrounds its banks, yet we hear little about the problem. Executives in China are often say that the government will simply bail out the system if there were a problem, but that discounts domestic political constraints as well as economic ones. For example, if the Fed, which can print the world’s reserve currency, could barely contain the US banking crisis, what makes us think that China can? Is this time different?

China GPD

A major shock to the Chinese economy would have a ripple-effect across the globe because of China’s massive demand for commodities and deep trade linkages with Western markets. When China sneezes, the world catches a cold.

JPMorgan estimates that loans originated by China’s shadow banks may comprise 69% of GDP.   With small Chinese businesses unable to secure bank loans, the shadow banking system has flourished.  Because of low official deposit rates and restrictions on putting money overseas, savers turn to the shadow banking market to earn higher yields, funding the risky credit cycle, while China’s large banks provide additional leverage via wholesale funding.

China GPD

The real risk is not that shadow banks go bad; in fact the Chinese government is actively trying to curb the industry’s growth. Instead the risk is that bad loans in the shadow system bubble up to the systemically important banks that provided wholesale funding, dramatically slowing China’s growth.  Officially, non-performing loans are only 1% of total bank loans, but credible private estimates put the number closer to 10% The problem became clear this June when the People’s Bank of China (PBOC, China’s Central Bank) engineered a cash-squeeze to pressure the shadow banks, and the banks stopped lending to each other pushing interbank rates to 13.4% overnight (SHIBOR).

China GPD

Before the 2007-2008 crises in Europe and the United States, similar interbank indigestion was a strong leading indicator of the looming credit bust.

While the Chinese government is taking actions to manage this risk, companies should also take action by building scenario plans into their long-range business plans.   Better to build in insurance, even for something perceived as low risk, as economic history has a tendency to repeat itself.

What the US Government Shutdown Means For Emerging Markets

Closed until further noticeThe Fed will delay the tapering of its bond buying program in response to the US government shutdown. For emerging markets this means a slower pace of currency depreciation into year-end, and the potential for limited short-term appreciation in markets that may have over-corrected, like Turkey and Indonesia. With currency depreciation slowing, fourth quarter GDP results may surprise slightly to the upside. The dollar-denominated ETFs that track local Turkish and Indonesian stock markets both increased 4% on the news.

Emerging Markets Opportunity Not Over

Currency-Volatility-Global-Performance-DriversRecent reversals in capital flows caused large and sudden currency devaluations, faster than many emerging markets expected or could manage. As a result, many market commentators have called this end of the emerging markets opportunity. That statement couldn’t be further from the truth. While companies should always expect challenges in emerging markets, the changing environment will also create a new set of opportunities.

FSG identified four ways companies can capture growth in this shifting environment:

  1. Leverage home-currency strength to win share back from emerging markets–based competition
  2. Double down on local production to reduce production costs
  3. Use balance sheet strength to earn financing margins
  4. Reassess customer segmentation to identify local customer “winners”

FSG looks at these strategies and the drivers of the changing global environment in our 2014 Global Performance Drivers report, now available for FSG clients.

What happened?

Capital flows reversed because of push and pull factors.  As the US economy continues to improve, the Federal Reserve is expected to reduce bond purchases, changing the risk-return payoff for portfolio investors, “pulling” capital out of emerging markets.  We also see slowing growth in emerging markets “pushing” capital to developed markets.  The outflow of capital is more concerning for countries like Turkey, Poland, and Ukraine, which have high levels of short-term external debt. Countries fitting this profile may run into short-term funding challenges that could drive up local interest rates, or in the worst case cause temporary liquidity problems. Other countries like India and Indonesia may now struggle with inflation as currencies decrease faster than is manageable, driving up costs for consumers.

Paying for Flexibility: An Expert’s Take on Mitigating Currency Volatility

U.S.-based multinational corporations lost an estimated $50 billion as a result of currency volatility in 2012.  As I referenced in my previous post, FSG projects currency volatility to increase in 2013.  No longer can executives only rely on corporate treasury to manage these risks as the potential impacts on profitability and performance are too great.

To better understand some of the operational strategies that executives can use to reduce currency risks, FSG turned to one of our expert advisors, Professor Gordon Bodnar:

  • GB: “I encourage companies to think about structuring their operations as much as possible to have flexibility to respond to unexpected currency movement.  If currency moves in our favor, can you take advantage of not just increasing dollar price and dollar revenue stream by providing additional service?  Same thing for operations on the downside, how are operations structured so that over the short-term you can make adjustments to the pricing or costs structure such that you see a devalued currency by 10% your costs rise by less than 10%”

Professor Bodnar's Explanation of Operational Hedging and Firm Value

  • GB:  “In markets with high volatility, the goal is an options type payoff.  Companies often don’t want to do this, as anytime you are creating an option there is an upfront cost.  However, the point is that the payment of the premium is necessary to get the payoffs you want…you have the ability to absorb and move across the profitability curve, leading to a higher expected payout”

Larger initial  local investments give executives the flexibility to respond to FX volatility with operational rather than financial strategies.

This is obviously a more risky strategy, and Professor Bodnar was kind enough to share a wide array of less risky strategies that I’ll cover in future posts.


Gordon Bodnar, Ph.D.

Gordon Bodnar is the Morris W. Offit Professor of International Finance and Director of the International Economics program at The Paul H. Nitze School of Advanced International Studies. He is presently a research associate of the Weiss Center for International Finance and also teaches in the Wharton Executive MBA program at the Wharton School at the University of Pennsylvania. Dr. Bodnar is also the associate editor of European Financial Management, Journal of Asian Economics, and Journal of International Financial Markets, Institutions and Money. He has held appointments as a Research Fellow at the National Bureau of Economic Research and the IMF. He received his Ph.D. in Economics from Princeton University.

As an FSG Expert Advisor, Professor Bodnar is available to FSG clients for consultation on many business issues with key areas of expertise including corporate and risk management.  Please contact your account manager for further information or contact us at


Emerging Market Currency Volatility…It’s Getting “Real”

“Currencies should not be used as a tool of competitive devaluation. The world should not make the mistake that it has made in the past of using currencies as the tools of economic warfare.”
- George Osborne, Britain’s Finance minister

For emerging market finance ministers, the concept and impact of “currency wars” is very real. As loose monetary policies in developed economies encourage high capital inflows to emerging markets (often referred to as “hot money”), emerging countries struggle to control inflation and the upward pressure on their currencies. This often leads to a surge in competitive devaluations as governments feel compelled to intervene in order to protect fragile domestic economic recoveries, which has the resulting consequence of amplifying currency volatility. However, these competitive devaluations should not be considered as “economic warfare”, they are economic stabilization measures and a natural result of expansionary monetary policy. As many media outlets implicitly (or probably explicitly) understand, conflict is much more exciting than accord. By emphasizing the antagonistic aspects of these decisions, they are unfortunately misleading the public into thinking that these interventions are purely for competitive purposes.

However, multinationals are impacted when emerging markets governments respond to capital inflows by more aggressively printing money to sell on the open market to buy hard currencies. The reality is that the selling of local currency to buy developed-market bonds creates a cycle that further depresses yields in developed markets, pushing more capital to emerging markets, restarting the cycle of currency volatility again. Unfortunately for international executives, currency volatility creates many problems, such as difficulties in:

1. Pricing products
2. Anticipating costs
3. Uncertain business planning
4. Greater reluctance to hire new employees
5. Price instability in commodity markets

For international executives that are increasingly focused on profitability, currency volatility is one of the most important trends to watch this year. For example, a 10% increase in profitability in a given market will be essentially wiped out by a 10% decrease in the value of the local currency when results are reported.

Currency Volatility Chart


Emerging Market View: What Our Analysts Are Reading – 3/8/2013

Here’s a look at a few of this week’s global headlines with added commentary by our research team members:

Market Watch’s Post-Chavez Venezuela: oil’s next Saudi Arabia?:

“As Associate Vice-President for Latin America Clinton Carter is quoted in this article, oil production is unlikely to experience any increase over the short term, as a necessary shift toward investments in PDVSA are likely to continue to be secondary to the need to fuel social spending and support any post-Chavez government.”
- Antonio Martinez, Senior Analyst for Latin America Research

The Financial Times reports new property market cooling measures put doubt on China’s economic recovery:

“China has launched yet another round of of cooling measures, including a 20% capital gain tax on property sold in the secondary market, higher down payment and mortgages, to contain property prices. This is will impact property and construction related industries, which represent a big chunk of the Chinese economy, adding new pressure to the fragile recovery.”
- Shijie Chen, Practice Leader of Asia Pacific Research

Reuters had an article on Brazil’s industrial recovery:

“Any sustainable economic rebound in Brazil will have to be led by the industrial sector, making this heartening news for multinationals concerned about a seemingly interminable slowdown in Latin America’s largest market.”
– Ryan Brier, Practice Leader of Latin America Research